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November 6, 2013

10 Tech Trends That’ll Rattle the Advisory Industry

Attracting Gen X and Y clients will be vital as boomers retire, but these changes will make it a lot more challenging

Corporate Insight noted that among the many challenges facing the industry, attracting younger clients to replace retiring boomers is one of the biggest. Attracting those clients will require many advisors to change the way they’re accustomed to doing business, though.

“Compared to baby boomers, members of Generations X and Y have higher expectations for online and mobile services and don’t see as much value in regular face-to-face meetings,” Corporate Insight noted in the report. “Many also have a skeptical attitude towards large financial institutions and have eschewed active investment management for passive, index-based ETFs.”

That attitude has given innovative startups an opportunity to grab younger investors’ business. Corporate Insight acknowledged that these services are unlikely to replace advisors completely, especially among high-net-worth clients, but they will have a measurable effect on the investment industry.

1. Algorithm-Based Investment Advice

Online financial services that use algorithms to provide financial advice typically start by asking users to complete a questionnaire about age, income, risk tolerance and investment preferences. These services are available at multiple fee scales, with the more expensive typically requiring more robust information.

Corporate Insight noted that these questionnaires are frequently superficial, and that the services rarely allow users to assign specific goals to investment accounts. Another drawback is that some users may feel uncomfortable executing the service’s recommendations on their own.

Some examples of these types of services include SigFig, which analyses users’ funds for high-cost or poor-performing holdings and suggests other funds, and Quovo, which targets small institutions like endowments and family offices.

We spoke with Grant Easterbrook, senior research analyst for Corporate Insight, in September about how these types of services will change the way investors get financial advice. “This technology is here to stay, whether or not some of these free services succeed or even paid ones,” he said. “I don’t think every one of these firms is going to succeed. Why it’s one of the most interesting groups is a lot of these firms have B2B partnerships, or B2B partnerships are soon to be announced. That makes them a lot more stable in the long term. If there’s a major correction they still have the revenues from their contracts. If it’s just B2C, that’s very hard. If trading goes down, people panic: then what happens to the firm?”

2. Trade Mimicking

Some startups have appeared that allow investors to copy the trades of other traders: sometimes professional managers, but friends and relatives or other traders are also possibilities. Corporate Insight identified two common ways they achieve this. One is to automatically copy the trades of a “trade leader. Investors can turn off trade mimicking at any time to invest on their own. The other method is to opt in to alerts about when the trade leader makes a trade. Investors will decide at each trade whether they want to copy it.

Trade leaders are compensated by the mimicking firm, according to Corporate Insight. Some let trade leaders set their own prices, but the most common pay schemes use a prearranged share of revenues or a share of the spread on forex trades.

The trade mimicking firm makes money by charging commissions on trades or subscription fees. Some examples of trade mimicking firms include German firm ayondo, which allows users to choose from a ranked list of traders; Currensee, recently acquired by OANDA, which vets forex traders and removes leaders from users account if they lose more than a specified amount; and Ditto Trade, a discount brokerage that lets users follow other customers.

Some drawbacks include how easy it is to switch managers. Corporate Insight noted that it’s likely investors will drop trade leaders when they start to lose and miss out when the market goes back up. There’s also the risk that investors won’t understand the tax implication of all their trades.

3. Low-Cost Online Managed Accounts

Firms that use this method have clients buy into the same basket of low-cost ETFs as a managed account but with their own allocation based on the results of a questionnaire.

Users don’t work with a manager or advisor, but have access to customer service. The minimum investment starts as low as $5,000 for many firms, and accounts frequently invest in passive index funds.

Corporate Insight identified two main drawbacks: an over-reliance on questionnaires, similar to algorithm-based services, and simply the lack of any relationship for the user. “Investors that work with a traditional financial advisor know that he or she is there to answer their panicked phone call, preventing them from taking huge losses during volatile periods and keeping them disciplined in their approach,” the report noted. “With no human account manager to reassure clients, many investors may pull money out of these low-cost managed accounts during a correction.”

Some examples of these types of firms include AssetBuilder, which offers eight index portfolio options that invest in Dimensional Funds; Betterment, which allows users to target multiple goals with different allocations; and the yet-to-be-released Invessence, which uses what Corporate Insight called a “notably detailed questionnaire” to address investors’ needs.

4. Online Financial Advisor Search Tools

Unlike the automated services previously mentioned that took advisors out of the relationship, these firms work to connect investors and advisors. Corporate Insight identified three different approaches for these types of firms. One is a dedicated search engine that allows investors to search for a vetted advisor from a list compiled from publicly available information. Consumers can search for advisors based on factors like location, services provided, gender or AUM, and many include rankings or reviews from other users. Some examples of these types of firms include Tippybob, which rank advisors on a 100-point scale based on questionnaire answers provided by clients, and BrightScope, which provides information on advisors and firms, as well as different retirement plans.

The second approach incorporates a proprietary list of advisors into an existing website. The third approach uses a matchmaking style. Consumers enter information about what they’re looking for, and the firm will identify possible matches.

These sites make money by charging advisors a fee to be listed. Some include listing for individual advisors or entire firms.

Corporate Insight noted that with consumers growing reliance on online research in other aspects of their lives, online search tools for advisors have some room to grow in the industry. However, boomers hold much of the wealth in this country and typically already have a relationship with an advisor. Another drawback is that these services need significant number of advisors to be useful, but many will be turned off until they see some benefits for themselves.

5. Online-Only Financial Advisors

While some automated services provide access to a personal advisor as part of their premium services, most stick to the automated model, Corporate Insight found. There are some firms, though, that attempt to provide online services similar to that of a traditional advisor relationship. By communicating through phone, email and video chat, these firms can charge lower fees, according to the report.

Corporate Insight noted that some large brokerages like Charles Schwab, TD Ameritrade and Fidelity already offer managed accounts where the client may have limited, if any, physical interaction with their advisor because they don’t have a local branch or simply prefer it. “The strong growth numbers of managed accounts at these firms suggests that an advisor relationship without in-person meetings is viable,” according to the report.

Some examples include eSavant, the online-only branch of Savant Capital Management and Mariner Holdings’ FirstPoint Financial, which charges a quarterly asset-based fee and has not established an account minimum.

6. Online Financial Planning and Budget/Cash Management Tools

With these tools, consumers take control of all of their financial planning. Corporate Insight noted a distinction between online financial planning tools and budgeting tools. Many online tools exist to help consumers track monthly spending and assign goals. However, “adhering to a strict budget is a necessary piece to the puzzle when it comes to achieving one’s financial goals, but budgeting alone is not enough.”

One obvious drawback is that these sites will only help consumers who are already inclined to be financially responsible. Furthermore, even if they sign up, consumers have to keep their information up-to-date and accurate. Corporate Insight expects some firms will incorporate account aggregation in the future as a way to keep consumers honest about their finances, and to simplify the data entry process.

Some examples of these firms include Goalgami and Planwise, both of which allow users to set specific goals and dates for when they hope to achieve them, and incorporate their spending habits to see how on-track they are.

7. Retirement Plan-Specific Advice

Some firms have launched online services that offer plain-English descriptions of a retirement plan’s rules and fees. Some, like BrightScope, may also compare them to other similar plans. Although most providers have information on hundreds of plans, Corporate Insight found, small plans may not be included, forcing participants to enter information on their own.

Other examples of these types of firms include Kivalia, which provides asset allocation advice for 401(k), 403(b) and 457 plans, and FutureAdvisor, which analyzes the selected plan based on costs compared to other plans and average account balances.

Corporate Insight noted that many participants in employer-sponsored retirement plans already have access to similar services through their plan sponsor. However, many sponsors use outdated or limited third-party tools as part of their online offering.

8. Customizable ETFs

Some firms allow consumers to build their own ETF. Investors own shares of each of the underlying securities rather than shares of the fund.

The two main firms that offer these services, Motif Investing and Folio Investing, don’t charge expense ratios.

Investors can buy a pre-packaged ETF or start from scratch. Motif allows investors to choose up to 30 different stocks; Folio allows up to 100.

Some of the drawbacks Corporate Insight identified are difficulties with the customization process: if the underlying holdings are rebalanced, it’s difficult to notify users who have made changes to the standard basket.

Fidelity and TD Ameritrade have experimented with similar schemes, but those tools treated trades as individual transactions with standard commissions, according to Corporate Insight. The report noted that most brokerages aren’t likely to adopt customizable ETFs for fear of cannibalizing their own managed product and trade commission revenue.

Corporate Insight noted that many of these sites are still in beta testing, so the report did not include profiles of individual firms. However, assuming these schemes take off, they could become popular among long-term investors who want more control over real estate investments, Corporate Insight suggested. They would also provide more access to new developments.

One limitation that might prevent real estate crowdfunding from ever taking off is the SEC’s requirement that investors be accredited; that is, they must earn more than $200,000 per year for at least two years; have a joint income of $300,000 per year; or have net worth over $1 million, either individually or jointly. However, on Oct. 23, the SEC voted to propose rules that would allow companies to sell securities to raise money through crowdfunding. Those rules would limit how much money a company could raise and how much individuals can invest. Investors who don’t meet the accreditation requirement might still be able to invest in startups if the rules are approved.

Some drawbacks are that it’s hard for investors to determine the value of a property that may be thousands of miles away without extensive information about it. It also requires investors be fairly sophisticated. Among the questions they need to ask are how the developers’ financials are audited and how they are compensated. This puts a large burden on the crowdfunding website. “Just like purchasing shares of a REIT is an investment in the wisdom of the REIT manager, using a real estate crowdfunding website means placing your trust in the vetting process and the expertise of the people who select the properties that are available on the platform,” according to the report.

10. Tuition Financing Startups

Corporate Insight identified three strategies for enterprising young students to finance their education and some firms that are capitalizing on that need.

Some firms are offering loans in exchange for a stake of the student’s future earnings. Funding comes from investors or from the firm itself. They commonly take between 3% and 10% of the student’s income for a set number of years, usually about 10 years. They may also provide some mentoring or support to the student to protect their investment.

Some examples of these types of firms are Pave and Upstart.

Another way students are funding their education is through micro-financing: asking for small donations from friends, family or their local community. Some examples of these firms include Give College and GradSave, which cater to parents, and Campus Slice and BrainFund, which help students solicit donations.

Corporate Insight was skeptical that these types of services would catch on as a major funding vehicle and suggested that they would be more successful as part of a broader service. Fees are expensive, and donations are likely to only come in a few times a year, consequently requiring a “huge number of customers” to be successful.

Finally, some students are securing loans from alumni. Some firms, like SoFi and CommonBond, are connecting students with benevolent alumni who would rather directly finance student loans than contribute to the school’s general fund. Students can get a lower rate than they would at a private lender, and the scheme appeals to charitable investors who want to feel like they’re supporting a good cause.

Currently, those providers are only available at a few institutions, but Corporate Insight had high hopes for their futures. “The ‘loans from alumni’ concept seems like a win-win. So long as the middleman keeps the fees reasonable, loans from alumni should become more common.”